Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Elasticity... u Demand elasticity is a measure of how much buyers respond to changes price, income, and other things. u Supply elasticity is a measure of how much sellers respond to changes in price and other things.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Flavors of elasticity n Price Elasticity of Demand n Income Elasticity of Demand n Advertising Elasticity of Demand n Price Elasticity of Supply

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Price Elasticity of Demand Price elasticity of demand: the percent change in quantity demanded in response to a percent change in price.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Price Elasticity of Demand Demand tends to be more elastic : u The larger the number of close substitutes. the longer the time period. the more narrowly defined the market. u If the good is a luxury.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Computing the Price Elasticity of Demand: A First Approach Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones then your price elasticity of demand is:

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Computing the Price Elasticity of Demand: Mid Point Method Demand is price elastic $5 4 Demand Quantity1000 Price 50

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Perfectly Inelastic Demand Qty demanded doesnt respond to price Elasticity=0 Quantity Price 4 $5 Demand leaves the quantity demanded unchanged. 1. An increase in price...

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Inelastic Demand A large percent change in price A small percent change in quantity demanded Elasticity < 1 Quantity Price 4 $5 1. A 22% increase in price... Demand leads to a 11% decrease in quantity.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Unit Elastic Demand Each 1% increase in price a 1% decrease in quantity demanded Elasticity = 1 Quantity Price 4 $5 1. A 22% increase in price... Demand leads to a 22% decrease in quantity.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Elastic Demand Small increase in price big decrease in quantity demanded Elasticity > 1 Quantity Price 4 $5 1. A 22% increase in price... Demand leads to a 67% decrease in quantity.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Perfectly Elastic Demand The smallest change in price Huge change in quantity demanded Elasticity is INFINITE Quantity Price Demand $4 At exactly $4, consumers will buy any quantity …and they wont pay a cent more …theyll buy something else if price rises at all. Demand facing a competitive firm.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Price Elasticity and Total Revenue u Total revenue is the price of a good multiplied by the quantity sold. TR = P x Q

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. $4 Demand Quantity P 0 Price P x Q = $400 (total revenue) 100 Q Total Revenue: A Picture

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Elasticity and Total Revenue n With inelastic demand, an increase in price leads to a small decrease in quantity demanded. n Total revenue increases when price rises. P x Q Increases when P rises

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Elasticity and Total Revenue n With elastic demand, a small increase in price leads to a big decrease in quantity demanded. n T otal revenue decreases when price rises. P x Q decreases when P rises

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Elasticity and Total Revenue: Elastic Demand Demand Quantity0 Price $4 50 Demand Quantity0 Price Revenue = $100 $5 20 Revenue = $200 An increase in price from $4 to $5... …leads to a decrease in total revenue from$200 to $100

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Income Elasticity of Demand u Quantity demanded responds to consumer income. u Income elasticity of demand: upercentage change in quantity demanded divided by the percentage change in income.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Computing Income Elasticity Income Elasticity of Demand Percentage Change in Quantity Demanded Percentage Change in Income =

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Income Elasticity - Types of Goods - u Necessities are income inelastic Examples: food, fuel, clothing, utilities, medical care. u Luxuries are income elastic. Examples: sports cars, jewelry, gourmet foods.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Use the midpoint method to calculate your price elasticity of demand as the price of compact discs increases from $8 to $10 if (i) your income is $10,000, and (ii) your income is $12,000. [(40 – 32)/36] / [(8-10)/9] = [2/9]/[2/9] = 1 [(50-45)/47.5]/ [(8-10)/9] = 10.5% / 22.2% =.47 Calculate your income elasticity of demand as your income increases from $10,000 to $12,000 if (i) the price is $12, and (ii) the price is $16. [(30 – 24)/27]/[(10-12)/11] = 22.2% / 18.2 % = 1.22 [(12 – 8)/10 ]/[(10-12)/11] = 40% / 18.2 % = 2.2

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Price Elasticity of Supply u Quantity supplied responds to price. u Price elasticity of supply the percentage change in quantity supplied resulting from a percent change in price.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Computing the Price Elasticity of Supply The percentage change in quantity supplied divided by the percentage change in price.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Perfectly Inelastic Supply Elasticity equals 0 Quantity Price 4 $5 Supply leaves the quantity supplied unchanged. 1. An increase in price...

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Inelastic Supply Elasticity < 1 Quantity Price 4 $5 1. A 22% increase in price Supply 2....leads to a 9 ½ % increase in quantity supplied.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Unit Elastic Supply Elasticity equals 1 Quantity Price 4 $5 1. A 22% increase in price Supply 2....leads to a 22% increase in quantity.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Elastic Supply E lasticity > 1 Quantity Price 4 $5 1. A 22% increase in price Supply 2....leads to a 67% increase in quantity.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Perfectly Elastic Supply E lasticity equals infinity Quantity Price Supply $4 At exactly $4, producers will supply any quantity.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Determinants of Elasticity of Supply Ability of sellers to change the amount they produce Beach-front land is inelastic. Books, cars, or manufactured goods are elastic. Time period Supply is more elastic in the long run than in the short run.

An Increase in Supply in the Market for Wheat $3 Quantity of Wheat1000 Price of Wheat Demand S1S1 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

3....and a proportionately smaller increase in quantity sold. As a result, revenue falls from $300 to $220. An Increase in Supply in the Market for Wheat $3 Quantity of Wheat1000 Price of Wheat 1. When demand is inelastic, an increase in supply... Demand S1S1 S2S leads to a large fall in price... Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

Summary u Price elasticity of demand measures how much the quantity demanded responds to changes in the price. u If a demand curve is elastic, total revenue falls when the price rises. u If it is inelastic, total revenue rises as the price rises.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Summary u The price elasticity of supply measures how much the quantity supplied responds to changes in the price. u In most markets, supply is more elastic in the long run than in the short run.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Graphical Review

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Computing the Price Elasticity of Demand Demand is price elastic $5 4 Demand Quantity1000 Price 50

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Elasticity and Total Revenue: Inelastic Demand Q d doesnt change much when price rises $3 Quantity 0 Price 80 Revenue = $240 Demand $1 Demand Quantity 0 Revenue = $ Price An increase in price from $1 to $3... …leads to an increase in total revenue from$100 to $240

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Elasticity and Total Revenue Elastic Demand Q d changes a lot when price rises Demand Quantity0 Price $4 50 Demand Quantity0 Price Revenue = $100 $5 20 Revenue = $200 An increase in price from $4 to $5... …leads to a decrease in total revenue from$200 to $100

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Perfectly Inelastic Supply - Elasticity equals 0 Quantity Price 4 $5 Supply leaves the quantity supplied unchanged. 1. An increase in price...

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Inelastic Supply - Elasticity is less than 1 Quantity Price 4 $5 1. A 22% increase in price Supply 2....leads to a 10% increase in quantity.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Unit Elastic Supply - Elasticity equals 1 Quantity Price 4 $5 1. A 22% increase in price Supply 2....leads to a 22% increase in quantity.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Elastic Supply - Elasticity is greater than 1 Quantity Price 4 $5 1. A 22% increase in price Supply 2....leads to a 67% increase in quantity.